EFN406: MANAGERIAL FINANCE Assignment: Part B Capital Budgeting Complete Solution
General Information
Answer the two problems below (P1 and P2). Five marks each. Part marks will be allocated, but if you have the incorrect answer then you cannot expect to get more than half marks.
Project 1
Polycorp is considering an investment in new plant of $3.1 million. The project will be financed with a loan of $2,000,000 which will be repaid over the next five years in equal annual end of year instalments at a rate of 6.5 percent pa. Assume straight-line depreciation over a five-year life, and no taxes. The projects cash flows before loan repayments and interest are shown in the table below. Cost of capital is 12.15% pa (the required rate of return on the project). A salvage value of $255,000 is expected at the end of year five and is included in the cash flows for year five below. Ignore taxes and inflation.
Year |
Year One |
Year Two |
Year Three |
Year Four |
Year Five |
Cash Inflow |
880,000 |
860,000 |
810,000 |
910,000 |
945,000 |
You are required to calculate:
Project 2 Calculations must be done in Excel
Polycorp Limited Steel Division is considering a proposal to purchase a new machine to manufacture a new product for a potential three year contract. The new machine will cost $1.5 million. The machine has an estimated life of three years for accounting and taxation purposes. The contract will not continue beyond three years and the equipment’s estimated salvage value at the end of three years is $128,000. The tax rate is 29 percent and is payable in the year in which profit is earned. An investment allowance of twenty five percent on the outlay is available. The after tax cost of capital is 12.85%pa. Addition net working capital of $72,000 is required immediately for current assets to support the project. Assume that this amount is recovered in full at the end of the three year life of the project. The new product will be charged $59,500 of allocated head office administration costs each year even though head office will not actually incur any extra costs to manage the project. This is in accordance with the firm’s policy of allocating all corporate overhead costs to divisions. Extra marketing and administration cash outflows of $68,500 per year will be incurred by the Steel Division for the project. An amount of $159,000 has been spent on a pilot study and market research for the new product. The projections provided here are based on this work. Projected sales for the new product are 32,000 units at $133 per unit per year. Cash operating expenses are estimated to be 75 percent of sales (excludes marketing and administration, and head office items). Except for initial outlays, assume cash flows occur at the end of each year (unless otherwise stated). Assume diminishing value depreciation for tax purposes.
Required
EFN406: MANAGERIAL FINANCE Assignment: Part B Capital Budgeting Complete Solution
Investment 3100000 Loan 2000000 Time 5 Interest 6.50% Salvage value 255000 Depn per year 569000 Straight line Cost of capital 12.15% Loan repayment schedule Annual installment $481,269.08 ...
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